Do consumers benefit from cheaper imports?

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The writer is a senior fellow of the Carnegie Endowment for International Peace

For decades, Americans have been told that low-priced imports are an unalloyed blessing. By purchasing goods produced more cheaply abroad, Americans can stretch their paychecks and raise their living standards. 

But this story muddles cause and effect. The real benefit of international trade is that it helps countries to maximise domestic welfare by maximising the value of domestic production. For the global economy, as well as for each individual country, it is only by producing more that we can consume more.

Cheap imports can actually have the opposite effect if they encourage lower domestic production. When the US runs a trade deficit, it is buying more from the rest of the world than it sells. The result is that rather than pay for American imports with goods and services produced in the US, Americans pay by transferring ownership of stocks, bonds, factories, real estate and other American assets.

What’s more, the American economy, with its largely open trade and capital accounts, automatically accommodates the weak demand in countries whose industrial policies are designed to boost their shares of global manufacturing at the expense of domestic demand. It does this by shifting American production from manufacturing to services, regardless of actual American preferences.

That’s why the simplistic claim that Americans “win” by getting cheap T-shirts from Bangladesh or cheap cars from China misses the point. Americans win from trade not when imports are cheaper, but rather when those imports cause a shift in American production that leads to faster productivity growth. In other words, if trade leads to a more rapid expansion in domestic production, workers will improve their welfare and consume more whether or not imports are cheaper. And if trade doesn’t lead to a more rapid expansion in domestic production, they will not improve their welfare even with cheaper imports.

Trade deficits are not necessarily harmful. A rapidly growing developing economy with strong investment opportunities might import more capital than it exports as it builds new infrastructure or expands production. In that context, a deficit can reflect strength. That is what characterised the US economy for most of the 19th Century.

But that is not what happens in the US today. In fact, by pushing up the value of the dollar and making American manufacturers less globally competitive, foreign capital may actually put downward pressure on US investment. We can see this in the tendency of American businesses to hold record amounts of cash on their balance sheets, even after they have spent trillions of dollars in stock buybacks, dividend payments, acquisitions, and the transfer of production facilities abroad. Clearly, in that case, desired investment in the US is not constrained by scarce saving, in which case foreign inflows will not increase domestic investment.

But more imports nonetheless mean that some American demand shifts from goods produced at home to goods produced abroad. And if there is no commensurate increase in foreign demand for American goods — because foreign demand is structurally too weak for its rising exports to be matched by rising imports — the US economy won’t respond by increasing domestic production to satisfy rising exports.

In that case it can respond in one of two other ways. Either American businesses must reduce production and fire workers, causing unemployment to rise, or domestic demand must be goosed with a rise in household or fiscal debt. And because US officials want to avoid the former, they usually choose the latter. Which means that while unemployment doesn’t rise, American debt rises and American workers must automatically shift from producing tradeable goods to producing non-tradeable services — again, regardless of actual American preferences.

As a result, whereas persistent US deficits in the 19th Century allowed American investment to rise and American manufacturing to grow, in the 21st Century persistent American deficits cause American debt to rise, productive sectors like manufacturing to decline as a share of the American economy, income inequality to rise, and growth in the economy to become more dependent on asset bubbles. None of these benefit American consumers.

If we truly want to maximise American consumer wellbeing, we must flip the narrative. The goal should not be to maximise cheap imports, as most economists mistakenly believe. It should be to maximise domestic production and productivity growth, and to ensure that the fruits of that productivity growth are broadly distributed. This is the only sustainable way to maximise welfare growth.

This doesn’t mean closing our borders to trade. Trade can be enormously beneficial if it is structured to support production. But when trade causes the economy to prioritise cheap consumer imports over production and investment — or when the goal of trade policy is to accommodate global trade and savings imbalances — it mainly benefits Wall Street. And this is at the expense of American workers, farmers, businesses and, yes, American consumers.

We must rethink the conventional wisdom that the purpose of trade in the US is mainly to lower the price of imports. Ultimately, rising consumption can only be sustained by rising production. That is why for the US to improve long-term prosperity, it must recognise that the only way trade boosts domestic welfare and consumption is by boosting domestic production. In the end, it is only rising productivity growth that sustainably drives consumption growth.